DBRS Morningstar Confirms Republic of Lithuania at A, Trend Changed to Positive

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Lithuania’s Long-Term Foreign and Local Currency – Issuer Ratings at A. At the same time, DBRS Morningstar confirmed the Republic of Lithuania’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trends on all ratings are changed to Positive.

KEY RATING CONSIDERATIONS

The Positive trends reflect DBRS Morningstar’s view that the Lithuanian economy continues to improve its economic resilience. The country has a diversified economic structure and remains among the euro area’s top growth performers. GDP growth has been stronger than expected, at 3.6% in the third quarter of 2019 on a seasonally adjusted annual basis, as private consumption, industry and construction performed well. The weak external environment could pose downside risks to growth, particularly for a small and open economy like Lithuania, but economic resilience has increased, fiscal policy is disciplined and the debt-to-GDP ratio is moderate.

The A ratings are underpinned by Lithuania’s sound fiscal position and its low public debt ratio. DBRS Morningstar views Lithuanian membership of the OECD in 2018 as a credit strength; meeting OECD standards and benchmarks, for example, underpin sound governance. Euro system membership since 1st January 2015 is another key credit strength. Progress with the reform agenda, including measures that reduce the tax burden on low income earners and narrow the employers’ tax wedge, as well as efforts to improve tax compliance, further support the ratings. Credit challenges relate to structural factors including income inequality; the need for further productivity improvements; a still low investment rate; the declining and ageing population; and economic informality.

RATING DRIVERS

Factors for an upgrade include: (1) continuation of a prudent fiscal approach (2) additional measures to improve Lithuania’s long-term fiscal sustainability, and (3) active government policies to raise the supply of skilled workers.

Negative rating drivers include: (1) a return of significant macroeconomic imbalances, particularly if accompanied by high credit growth or private sector dis-savings or (2) a material deterioration in the public debt metrics.

RATING RATIONALE

Economy Continues to Grow Without the Emergence of External Imbalances

Following growth of 4.1% in 2017 and 3.5% in 2018, the Lithuanian economy is projected to grow by 3.7% in 2019, driven by robust investment and consumption growth. Recovering European Union (EU) funds and high capacity utilization are providing support to investment growth. In addition, increasing employment and high wage growth underpin private consumption growth. The country will remain a net beneficiary of EU structural funds, with planned EU net inflows rising to 5.4% in 2020, up from 4.2% of GDP in 2017. The Central Bank forecasts growth to moderate to 2.5% this year as the impact of a weaker external environment takes its toll and consumption growth is expected to slow. The likely shrunken EU budget for Lithuania in 2021-2027 could have negative implications for Lithuania’s economic development, but over time as financial markets deepen, Lithuania will most likely adjust to become more self-reliant with respect to infrastructure-type project funding.

Wage growth is highly linked to policy changes such as the higher minimum wage and to skills shortages, despite an improving net migration balance. Income per capita adjusted for purchasing power parity is still only slightly above two-thirds of the euro area average. Future improvement is partially contingent on productivity gains.

Since 2009 Lithuania’s external position has strengthen significantly, shifting its current account position from a 15% deficit in 2007 to a small surplus in 2017. The current account surplus increased to 1.6% of GDP in 2018 from 0.9% the year before, supported by strong exports of services and a positive secondary income balance. From a stock perspective, a net international investment liability position of 60% of GDP in 2009 has decreased to 28% at end-September 2019.

A Good Fiscal Management Track Record, But Ageing Population and Other Factors Weigh on Fiscal Position

Since 2014 Lithuania has maintained its budget position in surplus due to favorable economic conditions and strong revenue growth. The solid budget position was also underpinned by expenditure ceilings and an independent fiscal council - the fiscal framework allows for effective counter-cyclical policy. As a euro system member, Lithuania also benefits from the European Commission’s (EC) economic governance and fiscal frameworks. The general government budget position remained in surplus in 2018 at 0.7% of GDP and is forecast to have declined to 0.1% in 2019 due to the 2018 and 2019 reform package. The 2018 and 2019 tax and pension reforms are a step towards addressing the country’s structural challenges, including the high labor tax wedge and income inequalities. According to the 2020 Budget the headline surplus is estimated at 0.2% of GDP.

Lithuania has one of the fastest ageing populations in the EU. To illustrate the demographic challenge, the old-age dependency ratio (15-64) is expected to rise to 63.9% in 2060 from 29% in 2016 according the European Commission. To help combat the challenge, the government implemented a reform in 2012 that gradually increases the retirement age for both men and women to reach 65 years in 2026, from 63.5 years for men and 62 years for women in 2017.

Another key government challenge is fighting tax evasion from Lithuania’s informal economy, measured as one of the largest relative to the size of its economy among EU countries. The practice of under reporting business income and of unreported envelope wages remains pervasive and obstructs a more efficient allocation of resources. Statistics Lithuania published official estimates of the non-observed economy at 14% of GDP in 2016. According to the IMF, when comparing revenues with the economy’s tax capacity, Lithuania’s tax collection level is estimated at 61% against 77% for central European economies in 2014.

Public Debt Vulnerabilities to External Shocks are Mitigated by a Low Public Debt Ratio and Strong Debt Management

Strong economic growth and improved fiscal conditions have placed debt on a downward trend. The debt to GDP ratio has been declining since 2015, when it reached its peak at 42.6% of GDP ratio, with the Ministry of Finance projecting the ratio to decline to 36.4% in 2019 and 35.1% in 2020. With its small and open economy, Lithuania’s public debt ratio, albeit currently low, is vulnerable to external shocks. However, Lithuania still has one of the lowest debt ratios among European countries, at 34.2% in 2018 compared with the Euro Area average of 85.1%.

With just EUR 115.6 million of short-term central government debt at end-October 2019, the government applies a conservative debt management strategy of extending debt duration in a low yield environment. The weighted-average term to maturity of central government debt was 6.7 years at end-October 2019. Almost all central government foreign debt is fixed rate and all the debt is in euros. Several debt controls are in place, including limits for municipalities’ borrowing and debt, while the Social Security Funds (Sodra) can only borrow with the permission of the Ministry of Finance.

Risks to Financial Stability Appear Contained

Most of the Lithuanian banking sector is foreign-owned, therefore, spillovers from vulnerabilities in parent banks is a persistent risk. That said, the financial sector is well capitalized and highly liquid. Nordic-Baltic cooperation is also being strengthened. While mortgage growth is high, at an annual growth rate of 8.3%% as of November 2019, DBRS Morningstar views the credit recovery consistent with extended catch-up following the significant crisis-related de-leveraging. The loan-to-deposit ratio has more than halved from 200% before the crisis. Moreover, private sector debt is relatively low. The debt-to-GDP ratio of non-financial corporations amounted to 43.29% and the household debt-to-GDP ratio was 23.08% in Q3 2019. The Bank of Lithuania has a counter-cyclical capital buffer (CCyB) of 1% in place in a period described as moderate systemic risk and among other factors credit and real estate market activity is high.

Notwithstanding the Stable Political Environment, Unexpected Geopolitical Shifts in Europe Could Pose Significant Risks

Presidential elections last May delivered a changed leadership, as Dalia Grybauskaitė’s presidency since 2009, was term limited. Her successor Gitanas Nausėda is expected to maintain policy continuity. DBRS Morningstar is of the view that EU and NATO membership are likely to provide a broadly stable political environment for Lithuania, but unexpected geopolitical shifts in Europe could pose significant risks.

Parliamentary elections are scheduled for October this year. Usually no single party wins an outright majority, so coalitions are needed. Successive multi-party government coalitions have helped to promote stable policies and institutions. DBRS Morningstar views that the recent decision by the Seimas of Lithuania to lower the current election threshold to 3 percent is likely to lead to a more fragmented parliament in the upcoming election.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.
http://www.dbrs.com/research/355481

EURO AREA RISK CATEGORY: LOW

Notes:

All figures are in Euros (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include: Ministry of Finance, International Monetary Fund, OECD, European Commission, Bank for International Settlements, United Nations Development Program (UNDP), Eurostat, World Bank, Ministry of Finance, Bank of Lithuania, Stockholm School of Economics in Riga, Lithuania Department of Statistics, European Central Bank, IMF, World Bank, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS Morningstar had no access to relevant internal documents for the rated entity or a related third party.

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see:
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Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Nichola James, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: July 21, 2017
Last Rating Date: July 12, 2019

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